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How to predict the economy

posted Aug 20, 2011, 12:29 AM by Simon Nguyen   [ updated Dec 26, 2012, 11:02 AM ]
The economy works very much like the human body. When the body functions as it should, the person is healthy and is able to carry out his or her tasks at full capacity. When the body fails to function as expected, the person is unable to operate optimally. Fortunately, the human body often exhibits signs and symptoms that indicate the person’s current state of health as well as possible future ailments. The same is also true for the economy. This article discusses three interesting indicators that could be used to measure and predict the economy.

1. The Housing Market

The housing market is one of the key pillars of the economy, and arguably the best economic indicator. As people see their homes (along with their jobs) as the foundation of their financial well-being, a stable housing market is a prerequisite to an optimal economy. 

In a stable housing market, interest (or mortgage) rates and home prices are opposing forces. Lower interest rates tend to lead to higher inflation, which in turn leads to higher home prices. Higher interest rates tend to curtail demand, which in turn lowers home prices. In other words, housing stabilization means there must be either high home prices and low interest rates or low home prices and high interest rates. An anomaly occurs when there are low home prices and low interest rates or high home prices and high interest rates.

The U.S. housing market is currently experiencing an anomaly, due to super low interest rates (a weak dollar) and low home prices (foreclosures & high unemployment). Until home prices and interest rates significantly part ways, the consumption economy is likely to continue to be sluggish and high unemployment is the norm.

2. Cosmetics Industry

There are two types of purchases: needs and wants. Cosmetic products and services are of the latter. When the economy is good, people want to enjoy a little and thus the cosmetics industry is booming. When the economy is bad or people think it will worsen, they will look to cut dispensable expenses and cosmetics are the most plausible. A sizable reduction in cosmetic purchases signals decreasing consumer confidence, which foreshadows cuts in other purchases. As consumption makes up a lion share of U.S. GDP, a slowdown will surely affect the economy. 

What is so useful about this predictor is that one does not need any statistics to gauge how well the industry is doing. A few weekend visits to one of the local beauty salons should be enough to help determine whether or not the economy is doing well.

3. Black Friday Sales

Black Friday sales are one of the most important economic indicators; it is also one of the trickiest to interpret. Many people, including some economists, make the grave mistake of immediately equating a strong Black Friday to an economy on the upswing. The truth is that the effect stemming from strong Black Friday sales is not unlike the now defunct Cash-for-Clunkers program. In effect, Black Friday is stealing sales from the rest of the holiday season. A super strong Black Friday does not guarantee that the overall holiday shopping season will also be robust or the economy is getting better.

Simon Nguyen, MA Economics